Piercing the corporate veil in France
International Financial Law Review
1987

Kenneth weissberg and Marie-Caroline Moissinac of Lette & Associés,
Paris examine the difference between theory and practice in relation to groups of companies under French law.

In April 1984 a District Court in Chicago ruled that Standard Oil Company of Indiana was liable for its share of the US$2bn damages caused to the French plaintiffs by the largest oil-tanker spill in history off the coast of Brittany in 1978. This ruling by the US Court was reached as a consequence of the doctrine known as 'piercing of the corporate veil'. The Chicago Court pierced the corporate veil of a Panamanian corporation ultimately owned by Stan-dard Oil of Indiana and declared this company liable for the damages incurred. Behind the corporate entity Amoco, the judges were looking for the real owner of the company, Standard Oil. As Amoco was in a precarious financial situation, the bill for the damages had to be picked up by its parent company.
Although this is a satisfactory conclusion from the French point of view the theory is not yet widely applied in France. Legislation has often been put before the French National Assembly in order to introduce in France a doctrine equivalent to the piercing of the corporate veil, but no law has yet been enacted.The most interesting bill was that pre-sented to the National Assembly by Cousté, Le Douarec and Bignon on April 2, 1973.
This bill defined a 'group of companies' as several corporations controlled by common shareholders, and provided for a special court, the Court for Croops and Conglomerates, which would have jurisdiction over all legal issues relating to a group. This court would determine whether a group existed, and whether a company belonged to the group.
Only shareholders or partners representing at least 10 per cent of the capital of a corporation and the Public Attorney would be allowed to bring an action before this court. The leading corporation of a group would be jointly liable with its affiliated companies for any amount of money which was owed and remained unpaid three months after the closing of the fiscal year during which payment was due. If the balance sheet of the affiliated corporation showed a deficit, the parent corporation would be compelled to indemnify the affiliated corporation for its losses.
Moreover, in the case of a takeover, minority shareholders could either leave the affiliated corporation after refund of their shares or remain in the affiliated corporation and receive an annual indemnity to compensate them for any losses resulting from the takeover.
However, as with prior attempts, this bill did not become law . Although the vast majority of practitioners recognize the need for legislation on groups of corporations, it seems that the French legislator is afraid of the possible consequences for the restructuring of French industry. Nevertheless, in France as in most industrial nations, groups of corporations are an economic reality . There is growing legal concern as to how they should be treated by the courts.
The characteristics of a group are : the existence of several corporations with distinct assets; the dependence of some corporations on others because of direct or indirect control over their management by a common shareholder; a financial link between such corporations. Industrial reorganisation has led to the emergence of large corporations, and the control of some leading corporations over others involves the existence of a group interest, which is not always identical to, and may even conflict with, the interests of each corporation within the group.
Although the basic rule of current French law is still the legal autonomy of each legal entity this rule is increasingly being altered by case law . If the concept of groups of corporations has not yet been fully recognized, legislators and judges have been gradually taking it into account in order to ensure some protection for minority shareholders and creditors against the negative aspects of group organisation.
Their two main concerns are to compel groups of corporations to comply with the law wherever the group structure would permit an evasion of its requirements, and to ensure the protection of third parties and minority shareholders of dependent subsidiaries. The existing legal limitations to the activities of groups of corporations fall within different fields of law (corporate, tax, bankruptcy labour contract and criminal business) of which the most important is corporate law.
Under French law there are four major kinds of corporations: a joint stock corporation or Société Anonyme (SA); a limited liability company or Société à responsabilité limitée (SARL); a limited partner-ship with shares or Société en Commandite par Actions (under the same rules as the SA); an incorporated sole proprietorship or Entreprise Unipersonnelle à Responsabilité Limitée (under the same rules as the SARL).
In addition, the statute of July 12, 1985 provides that in an SA the voting rights belonging to the 'auto-control shares' (see box on p 34) will be taken into consideration only to the extent of 10 per cent of the votes of the shareholders who are present or represented at the general meetings of the shareholders. Violation of these provisions is punishable by fines ranging from 6,000 to 20,000 francs, and minority shareholders may sue the company in which they are shareholders for damages incurred by them as a result of such violations.

Cross-participation

Under the statute of July 24, 1966, which governs corporations, an SA is forbidden to hold any shares of another SA which holds more than 10 per cent of the shares of the first SA. ASARL may not hold more than 10 per cent of the shares of an SA which holds any share of the SARL, nor any shares of an SA which holds more than 10 per cent of the shares of the SARL.When a corporation acquires more than 10 per cent of the shares of another corporation, it must notify the latter by registered mail within one month. If the prohibitions above apply, the corporation which holds the smaller share of the capital of the other must disinvest within one year In the meantime, the corporation cannot vote with the shares that it is compelled to sell.
Recent instances of auto-control were reported in the press with respect to the bankruptcy or quasi-bankruptcy of two major French conglomerates, Creusot Loire, and Suez-Saint Gobain-Pont a Mousson. In the case of Creusot Loire, which belonged to the Empain-Schneider group, some directors of the group had acquired a small part of the capital of the companies of their group, and thus became the real decision-makers of the group thanks to cross-participation in the group's capital structure. When Creusot Loire fell into financial difficulties, the managers turned down outside offers to invest in Creusot Loire in order to keep control over the group, and it was thus impossible to salvage Creusot Loire, which was ultimately put into compulsory liquidation.
In the Saint Gobain-Pont a Mousson case, there was a merger between Saint Gobain and Pont à Mousson.The Suez Group, which owned 20 per cent of the assets of Saint Gobain, acquired the same participation in the new company created by the merger. The other shareholders of the new corporation complained to the "Commission des Opérations de Bourse" (COB; the French equivalent of the Securities and Exchange Commission) about management decisions contrary to their interests. The managers were suspected of having carried out forbidden cross-participations, by inflating the number of shares and by atomising the capital which pre-judiced the shareholders.
However, legal proceedings were never instituted because a solution was reached through a panel of specialists who acted as conciliators and demonstrated that the grievances against the managers were not justified. Nevertheless, this conflict illustrated the drawbacks of auto-control.
There have been attempts to regulate cross-participations. For example, the manager of a corporation has an obligation to inform the creditors and shareholders of the corporation as soon as the company holds 10 per cent of the shares of another company, and this has to be mentioned by the directors and auditors in their annual report to the sharehol-der's general meeting. Additional information has to be given if the company holds more than 50 per cent of the other company.
A diagram must also be attached to the balance sheet clearly showing the corporate structure of the group. The auditor's report must mention any acquisition of some significance in other French companies and all information pertaining to the auto-control, and any acquisitions of shares of the company by a third party during the course of the fiscal year .Violations of these reporting requirements are liable to criminal sanctions.
The parent company whose shares are listed on the official Stock Exchange must submit yearly consolidated accounts. (This rule will apply from 1990 to non-public parent companies.) These consolidated accounts must show the financial situation and the overall results of the group as a whole.
The 1985 law also requires any person or legal entity which acquires more than 10 per cent of the shares of an SA to notify the SA within one month of the total number of shares it owns. In addition, a company which is controlled directly or indirectly by an SA must notify the SA of the number of shares it owns, either directly or indirectly, every time there is a modification in the number of shares held.
Tax law tends to encourage the proper development of groups of companies while preventing groups from obtaining unfair tax advantages.Tax law does not consider groups as legal entities, but takes into consideration the links between companies in order to regulate certain issues.
Parent companies, for instance, only pay corporate tax on five per cent of the dividends received from their subsidiaries. Parent companies may also redistribute to their shareholders the dividends received from their subsidiaries together with the benefit of any tax allowance or tax credit relating to these dividends.
However, this option is restricted to parent companies having a real influence over their subsidiaries. Such influence is recognised either when the parent company holds at least 10 per cent of the shares of its subsidiaries, or when shares have been purchased as part of a merger. In each case the shares must have been fully subscribed at the time of their issuance or, if this is not the case, the company must have held them for at least two years.
French companies which directly or indirectly hold at least 95 per cent of the capital of another company situated in France for tax purposes can be authorised by ministerial decision to act for tax pur-poses as if both companies were one entity
French companies may also, with the authorisation of the FrenchTax Department, calculate their taxable profits either by grossing up the result of all their activities in France and abroad (worldwide profits), or by grossing up the dividends they receive from their foreign subsidiaries in which they own, directly or indirectly, 50 per cent of the shares (consolidated profits).Tbe company may deduct the corporate tax paid abroad by its foreign subsidiaries from the French corporate tax it has to pay.
In theory, under French law a company which is subject to corporate tax and which does not ask any interest on loans from its debtors is likely to be penalised by the French tax authorities, who will tax the company's profits as if interest had been paid. However, in the case of a parent company which grants interest-free loans to its subsidiary, this is considered normal behaviour, and in order to challenge this practice, the authorities must show that in so acting the parent company has deliberately pursued a goal unrelated to its own activity and has not attempted to consolidate the situation of its subsidiary or to help its development.
Bankruptcy law provides rules applicable to groups of companies under two statutes. These are the 1967 law on receivership and compulsory liquidation (règlement judiciaire and liquidation des biens), which is applicable to all bankruptcies prior to January 1, 1986, and the 1985 law which replaced this statute and took effect from January 1, 1986 (redressement judiciaire and liquidation judiciaire).

Bankruptcy procedures

If the compulsory liquidation of a corporation results in a loss, the courts may hold liable one or more managers, jointly and severally or individually for all or part of the loss, provided they have mismanaged the corporation so as to have contributed to the bankruptcy This liability applies to both de jure and de facto managers. Hence, a company which exercises ultimate control over the management of a bankrupt company may be found liable for the debts of the other, whether or not this controlling company was legally in charge of the management. For instance, two foreign companies have been considered to be the actual managers of a bankrupt French company because of their interference in the management of the latter, in particular for having placed in the company a person whose function was to provide them with reports on the activities of the company (Cass Com June 81982, Bull Cir 1V578).
Moreover, the court may extend the bankruptcy of a company to another company if contusion of assets of the two companies or the fictitious nature of one of them is proven. The consequences of this procedure are somewhat different. Here, only one liquidator is appointed for both companies, and all the assets of both companies are merged.This procedure applies mainly in cases of de facto confusion of assets among the companies.
In labour law there is a growing tendency to consider a parent company and its subsidiaries as one and the same, for example in the case of employment contracts. Although the parent company is not responsible for commitments undertaken by any of its subsidiaries, it may be found liable by labour courts where the parent company has contributed to the hiring of its employees and where the parent company has behaved as if it was the employer.
Whenever a doubt exists, employees can claim their salaries and fringe benefits from the parent company even though it was not officially the employer .Labour courts are particularly favourable to the interest of employees in cases of transfer of personnel within groups or dismissal for economic reasons.
In takeover cases, the labour code ensures that the new company is bound by the contracts of employment signed by the former company which it succeeded. Also, when a parent company transfers to a foreign subsidiary an employee who is bound to this subsidiary by a contract of employment, upon termination of this contract, the parent company is responsible for the employee's repatriation and for providing him with a position equivalent in importance to that which he previously occupied in the parent company before being transferred to the foreign subsidiary.
The law requires companies with more than 50 employees to establish an employee representation committee (Comite d'Entreprise) made up of elected members of personnel, and chaired by the chairman of the company or his delegate.This committee must be consulted on important subjects such as structural modification (sale of important part of assets, mergers and acquisitions), job classification, wage scales, working hours, contractual and legal profit-sharing schemes, dismissal of union representatives, employee delegates or members of the committee and economic dismissals.

Employee benefits

As a general rule, the union representation of the employees is organised in each separate company and consequently a representative committee is organised in every company However the law requires the organisation of a single board of employee's representatives for the whole group in the case of a group of companies or even between companies which have an economic and social similarity recognised by a court decision or an agreement.
In companies employing more than 100 persons, a percentage of the profits of the company must be distributed to the employees. Agreements between union and employers may be reached at group level in order to average out results among the subsidiaries of the group. Dividends are then calculated for the employees according to the results of the whole group. Such agreements must be authorised by the Ministry of Economy and Finance and the Labour Ministry subject to the opinion of a special administrative committee.
As a general rule of contract law the creditors of a subsidiary cannot act against the parent company to obtain payment or execution of obligations contracted by the subsidiary. However, case law has set three exceptions to this principle. First, the parent company can be found liable for obligations contracted by its subsidiary if it has created an appearance that it was guaranteeing the fulfilment of said obligations; for instance where the parent company had direct relations with the counterpart of its subsidiary or if the parent company exercised control over the contracts executed by its subsidiary.
The parent company will likewise be liable under the law of torts if it has committed a fault. For instance the Court of Appeal of Aix-en-Provence ruled that a defendant parent company created a deceptive appearance (both companies were situated in the same building, had the same telephone number, same commercial paper) and by different actions caused the ruin of its subsidiary. (C Aix en Provence, June 18 1975, Rev Jur Com 1976, 95 n 770 note Calais-Auloy.)
The parent company will also be liable if the subsidiary is a sham created in order to escape payment of debts.The Cour de Cassation decided that a SARL was a fictitious entity when its purpose was to cover up the commercial activity of its parent company, a real-estate agent. (Cass May 23 1978, JCP 78 IV 228.)
In a recent decision, the Court of Appeal of Versailles (17 Bept 1986, D87 p41) confirmed a judgement of the lower Commercial Court which had held Saint-Gobain Vitrage SA responsible for the unlawful termination of an agency agreement existing between Indecom International Development Company, a company incorporated in Saudi Arabia, and Exprover SA, a Belgian holding company created by the Saint-Gobain group to control its exports of glass products.
The Court of Appeal found that although Exprover SA and Dimover, its Middle-Eastern subsidiary for distribution of glass products, were corporate entities, governed by the rules of corporate law, their legal personality was so tenuously distinct from that of Saint-Gobain, that they did not even appear on the group's chart of subsidiaries and holdings. Hence these companies were to be considered merely as agencies of Saint-Gobain, rather than independent entities.
In addition, the original distributorship agreements had been negotiated between Indecom International flevelopment Company and Saint-Gobain Vitrage, which thereafter directed all the operations for the delivery and the invoicing of the goods ordered as a result of Indecom's activity The Court held that consequently, there was no real link between Indecom and the companies designated by Saint-Gobain to fulfil the orders, invoice the clients and pay commissions to Indecom, these companie acting merely as delegates of Saint-Gobain.

Corporate fraud

In criminal business law groups of companies which breach the above mentioned prohibitions are subject to criminal penalties. Moreover, agreements between companies for economic cooperation leading to a distortion of economic competition are expressly prohibited under the 1945. Act on prohibition of agreements leading to a monopoly situation. In addition, case law shows a greater recognition of group interest alongside or against the company interest than in other fields of law.
Criminal business law, has a far longer reach towards the ultimate wrongdoers than does commercial law. Anyone who exercises managerial power in a company can be held legally responsible for corporate frauds, and thus parent companies can be found liable for the actions of subsidiaries which are deemed fraudulent vis-à-vis third parties.
Judges, however, take into account the psychological and moral aspects of human error In the famous Rozenblum and Willot cases, the criminal courts held that there was no breach of trust when the assets of the company had been employed by the managers in the interest of the group of which the company was a member.
The Willot brothers were at the head of a group of companies when they decided to take over the firms Saint-Frères, Le Bon Marché and La Belle Jardinière. They were prosecuted for breach of corporate trust and for overvaluation of corporate assets. It was said that they had used a sophisticated financial scheme to buy Saint-Frères mostly with the assets of Saint-Frères itself, that they had employed the assets of Le Bon Marché to eliminate a group of minority shareholders of this company, and paid for the acquisition of La Belle Jardiniere with shares of other companies of the group which were overestimated.
Although the court held that the group interest could not justify a consistent policy of transfer of economic values within the group, leading to the enrichment of certain companies of the group at the expense of the shareholders of other companies of the group, the court took into consideration the economic interest of the group as a whole and held that there was no fraudulent overvaluation of the several companies' assets.
In the Rozenblum case, 43 companies belonging to the same group fell into bankruptcy and the managers were prosecuted for breach of trust relating to loans totalling 11,526,892 francs granted by a real-estate agent to six companies of the group operating different businesses. The Criminal Court held that there was a breach of trust. In reaching this decision the Court applied the same rules and jurisprudence as in the Willot case, and considered an absence of group interest in the present case which could have justified the existence of loans thanks to a common policy of the group.
It may be added that the court decision to reject the group liability does not necessarily require a highly-structured organisation of the group: it suffices to establish the need to pursue a common interest, in other words, a policy designed for the whole group.
A bona fide common policy may result from the related object of the companies composing the group. As for the sacrifices imposed on one company of a group, in every case compensation must be provided to the victim company, and the level of the sacrifice must not be disproportionate to the financial capacities of the said company.
A group theory is emerging under French law, although statutes and courts are still quite cautious in referring to it expressly. In the future, it may be expected that a greater development of this theory will result from EC laws, as the EC Commission is currently preparing a project for regulation of groups of companies.